David Woo, global head of rates and currencies research at BofA
Merrill Lynch, suggests the next "pain trade" is betting on
Treasuries.

On the other hand, Woo's counterpart at Société Générale,
global head of rates and FX strategy Vincent
Chaigneau, says the next pain trade is betting against
Treasuries.

The "pain trade" refers to a crowded trade that goes in the wrong
direction, causing more damage to more portfolios than any other
trade — so it can't really be both long Treasuries and short
Treasuries at the same time.

But both are using the phrase to support their respective
calls on where the market is going next: BAML is currently
advising clients to short Treasuries, and SocGen is advising just
the opposite.

"Our discussions with clients suggest
that many market players, perhaps too many,
want to be short here," says Chaigneau. "That may be
the pain trade just now, in an environment where inflation
continues to surprise to the downside (U.S. CPI for September
reported at just 1.2% yoy, with core up only 0.1% mom, EMU HICP
at just 0.7% yoy in October) and growth remains
soft."

In other words, Chaigneau
thinks Treasuries are going to continue to rally, catching the
majority (which wants to be short, according to the SocGen
strategist) flat-footed.

Chaigneau
says the team remains "cautiously bullish on U.S. Treasuries,
with yields likely drifting down 10-20 [basis points] over coming
weeks."

Woo, on the other hand, argues that the "pain trade" is in the
other direction — investors long Treasuries will experience the
most hurt — supporting BAML's short-Treasuries call initiated
October 25.

"The September FOMC meeting and the October government
shutdown precipitated a big shift in the consensus over the
tapering timetable, leading to a major repricing of markets over
the past six weeks," says Woo, referring to the rally in the
Treasury market since September 18, when the Fed unexpectedly
refrained from tapering down its quantitative easing
program.

"This seems to have finally run its course," he writes.
"Where are we now? Where are we going next? What is the next pain
trade?"

The AUD/USD volatility curve suggests the market is
pricing March as the most likely timetable for the tapering
announcement.BofA Merrill Lynch
Global Research

Woo is looking at forward exchange-rate volatility curves, which
he says "allow us to gauge more precisely when the market
expects tapering to start."

"The fact that the forward curve of [1-month] AUD/USD
volatility peaks four months from now (near the level of
[1-month] volatility just before the September FOMC meeting)
leaves little doubt that March is the market’s new central
scenario for the start of tapering," says Woo.

The BAML strategist believes that because of this new
consensus in the market that tapering doesn't begin before March,
investors are piling into carry trades — which do well in
environments of low interest-rate volatility and happen to be
what SocGen has been recommending to clients lately.

"If the market was too confident about September tapering
six weeks ago, it may be too confident about March tapering now,"
he writes. "This is why we like running short rates, long USD and
long volatility positions going into Friday."